Lack of consistency on climate change reporting worries investors
22 Oct 2019
The quality of reporting on climate-related issues is falling short of investors’ expectations with a lack of consistent comparative data and analysis, while materiality issues are frequently ignored
22 Oct 2019
As economies begin to move towards low carbon and climate resilient futures, the latest Financial Reporting Council (FRC) Financial Reporting Lab report on climate-related corporate reporting highlights the gap between current reporting and investor expectations and calls on companies to prioritise reporting of this increasingly important area.
It also says companies should adopt the Task Force on Climate-related Financial Disclosures (TCFD) framework to report on climate-related issues, rather than using ad hoc reporting approaches.
The report noted that different companies have taken different approaches to climate change reporting, with some having a more decentralised structure, others using cross-firm working parties, and others running a ‘nominated’ person approach with input from other areas.
Some companies have also reassessed their risks within a climate change context by trying to draw out whether, at a cross-organisation level, there is a different risk level to that which they may identify in either a top-down or bottom-up risk format. Understanding management reporting tools in this context can be important.
The lack of consistency in reporting and disclosures, and box ticking approach to the issue, was also flagged in a new report commissioned by the Department for Business, Energy and Industrial Strategy (BEIS) and prepared by Big Four auditor PwC, which assessed company views on the value for climate change reporting.
It found that ‘while many respondents welcomed the emergence of non-financial reporting as a way of focusing a company’s attention on their strategic purpose, there was a strong view that the quality of reporting varies greatly between companies. It was also thought that for many businesses, the provision of this information is merely an exercise in compliance rather than a meaningful assessment of the risks to their organisation’.
There was also concern that the way materiality is reported in the context of climate change was sub-standard, with respondents criticising the lack of materiality and a lack of trust in the rigour and/or accuracy of non-financial content as a result of a lack of assurance.
‘Materiality was also a key concern for respondents, particularly in terms of how significant and specific the risks identified are, and in relation to their potential impact,’ the BEIS report by PwC said.
An interviewee from ClientEarth, a firm of environmental lawyers, said: ‘Reporting so far is very inconsistent. Feedback we hear from investors is that narrative information about climate change-related factors is very incomplete, inconsistent and difficult to compare. It makes it very difficult for investors to do robust analysis based on the information that’s been disclosed.’
The Lab also warned that there was ‘a challenge in not narrowing down the possible risks too early. Companies suggested thinking as broadly as possible, including considering whether the risk management process itself is capturing the interconnected elements of the risks and opportunities’.
Some listed companies, including Unilever, Barclays, SSE and DS Smith, used a roadmap of planned disclosure as a benchmark indicator of where they aimed to be and what they were trying to achieve.
The report stated that ‘as a minimum, companies should make an assessment of whether climate-related issues are relevant to their business model by looking at the possible effects that it might have in the future.
‘Investors want to see companies explain how they have assessed materiality, even if the outcome of that assessment is that it is considered not to be material. Investors acknowledge that for some companies it can be difficult to see the short-term impact, as it may not yet be having a financial impact.
‘Given the likely impact to the future business model, investors may consider it to be a material issue. For example, if a business segment is only partly at risk from physical risks now, but is a growing part of the business, this can have a large impact and may, therefore, be considered material.’
A number of companies use science-based targets, which involve adopting targets to reduce green house gas (GHG) emissions in line with what the climate science says is necessary to meet the goals of the Paris Agreement.
Wider government policy on climate change targets is a critical issue for investors. They are particularly interested in what that means for the company and how they are intending to reach those targets.
‘With action from governments, including the UK government legislating for net zero emissions by 2050, investors want to understand how companies are going to react to those types of challenges over a longer-term horizon, what strategy will help the company get there and how this is being monitored,’ the Lab report warned.
The Lab recommends companies use the Task Force on Climate-related Financial Disclosures (TCFD) framework to report on climate-related issues, which was the most widely cited framework used by listed entities. This will become the recommended modus operandi from 2022 when the UK government expects all listed companies and large asset owners to disclose in line with the TCFD recommendations.
TCFD expects companies to disclose the organisation’s governance around climate-related risks and opportunities. This includes describing the board’s oversight process and the management’s role in assessing and managing climate-related risks and opportunities.
While there is no mandatory requirement to report on climate change, companies should provide information on their impact on the environment, their principal risks, how directors have considered the long-term success of the company and, where material, the impacts on their financial statements.
The Lab report provides practical guidance about where companies can improve their reporting. The report also outlines what investors want to understand, questions companies should ask themselves, recommended disclosures, and a range of examples of the developing practice of climate-related reporting.
Earlier this year, the FRC published a statement outlining the responsibility of boards of UK companies to consider their impact on the environment and the likely consequences of long-term business decisions on climate change.
Sir Jon Thompson, CEO of the FRC, said: ‘Investors are rightly demanding more information and greater transparency from companies on the challenges posed by climate change.
‘As societal and investor expectations evolve, alongside the regulatory environment, it is clear companies need to rapidly increase their transparency and improve their reporting to meet this demand.
‘The FRC itself recognises the need to play a more active role in this space and this report is an important step in recognising climate change as a priority and building on the FRC’s activities.’
FRC Lab report, Climate-related corporate reporting: where to next? issued Oct 2019
BEIS Stakeholder perceptions of non-financial reporting issued Oct 2019